Friday, July 25, 2008

Want A World Full of Reckless Idiots? A Culture of Bailouts Will Work Pretty Well

The Federal Reserve and government regulators are largely propping up the lifestyles not of the middle class in general, but of various individuals who made choices that turned out badly and prefer not to live with the consequences. These include people who bought houses they now can't afford, executives at banks such as Bear Stearns and people who invested in reckless institutions like Fannie Mae.

Only a small number of these people are blameworthy.

Most simply made reasonable choices that didn't turn out very well. But people make reasonable choices that don't turn out very well all the time, and we don't bail them out. What about the people who bought SUVs just before the prices of those vehicles fell? Should they get bailouts? Should the government reimburse everyone who made the mistake of "upgrading" to Microsoft's Windows Vista?

When you shield people from great risks, you deny them the opportunity to earn great rewards. The culture of bailouts raises the price of risky assets, which makes it harder to get rich by buying them. We all have different risk tolerances, so it's a good thing that the market offers a great range of options.

When you make the riskiest assets less risky (and simultaneously less lucrative), you reduce that range of options. At the same time, you dilute the incentive for shareholder oversight, which leads to lower productivity, lower incomes and lower wages. In the long run, that's no favor to anybody.

~Steven Landsburg in
today's LA Times

MP: If you make the world safe for idiots (and reckless borrowers, investors and executives), you'll create a world full of idiots (reckless borrowers, investors and executives).

28 Comments:

At 7/25/2008 12:35 PM, Anonymous Fred said...

Nothing is foolproof given nature's astonishing capacity for the invention of new and improved fools.

 
At 7/25/2008 3:05 PM, Blogger juandos said...

"Nothing is foolproof given nature's astonishing capacity for the invention of new and improved fools"...

No doubt!

Can you say Berlin?

 
At 7/25/2008 3:18 PM, Anonymous housingman said...

So...you're suggesting to let Fannie and Freddie just fail then? That would pretty much destroy the secondary market and make it impossible for anyone but private banking customers to get mortgages. Which would probably cause housing prices to drop another 20% because they would become ultra-illiquid.

 
At 7/25/2008 4:00 PM, Anonymous Anonymous said...

A bunch of libertarian crap. Carpe Diem has pimped the value of theMorgan Stanley Global Stock Index (how wealthy we all are) but fails to pimp the indebtedness of the USA (how poor we are). Asset values are variable. Debts are fixed. No?

Curiously, Carpe Diem has been silent about the nationalization of the mortgage market through an unlimited Treasury/Federal Reserve back stop of Fannie and Freddie. OOPS, the Federal Home Loan Bank is in ever deeper doo-doo. Why do you think that the Bush43 administration wants to up the debt limit to $10.6 trillion?

Way to go George. Just a bunch of drunks on Wall Street that need to be bailed?

The culture of bailouts privatizes gains and socializes losses. Libertarians ala Milton Friedman should be curling up in the corner and meowing before the torches and pitchforks take them out of their misery.

 
At 7/25/2008 4:48 PM, Blogger juandos said...

anon @ 4:00 PM says: "Carpe Diem has pimped the value of theMorgan Stanley Global Stock Index (how wealthy we all are) but fails to pimp the indebtedness of the USA (how poor we are)"...

So what are you suggesting anon, that we should be applauding people who through their OWN fault put themselves in debt?

Did you forget this part of the story you linked trying to dis Dr. Friedman? "What Friedman-Schwartz say was that incompetent government bureaucrats at the Fed had caused the Depression."

Nice bit of Monday morning quarterbacking by Anna Schwartz but I don't doubt for a minute what she has to say...

housingman says: "So...you're suggesting to let Fannie and Freddie just fail then?"...

So what are YOU saying? Should the taxpayer keep proping up these obviously useless government agencies?

How about you housingman and your fellow travelers, would you all be willing to dig deeper into your pockets to prop up these two agencies?

 
At 7/25/2008 5:05 PM, Anonymous QT said...

Anon.

How do government bailouts discredit libertarianism. Bailouts are surely the hallmarks of socialist interventionism not libertarianism.

With a libertarian approach, wouldn't we see something more like:

1. Fred & Fan would not exist because the market already provides plenty of options for financing;
2. government meddling in zoning, site plan approval, etc. would not restrict the supply of housing driving up prices in many jurisdictions like Boston, Florida & California.
3. lending institutions would not be forced to loan money to borrowers with poor credit history, and inadequate collaterol
4. monetary policy would have been more disciplined; part of the reason for the present difficulties is interest rates held too low for far too long creating "froth" in the housing market

In short, it is unlikely that the U.S. would be in the present predicament and it is equally unlikely that any libertarian approach would involve throwing money at the problem.

What we are watching is brush fire management. The fact that there is an inordinately small handful of libertarian members in the Republican party does not make the majority view nor the present approach by the Bush administration libertarianism in action.

 
At 7/25/2008 5:14 PM, Blogger juandos said...

"What we are watching is brush fire management. The fact that there is an inordinately small handful of libertarian members in the Republican party does not make the majority view nor the present approach by the Bush administration libertarianism in action"...

Yes indeed qt!...

I can't help but think that much of the idea that all Republicans are either conservative and or libertarian in their political outlook is the result of fifty plus year drumbeat by those fine folks in the MSM...

 
At 7/25/2008 5:42 PM, Anonymous housingman said...

"So what are YOU saying? Should the taxpayer keep proping up these obviously useless government agencies?"

Fannie and Freddie don't own that much in subprime; that isn't their issue. What they own are the vast majority of normal, conforming 30-year fixed, et al. products that your regular person has as a mortgage. The vast majority of people are paying their bills, and these mortgages are in no real risk of default. The risk lies in the fact that the mark-to-market of the underlying asset--the house--has fallen like 20% across every market; something that well, was generally consider not that high of risk. And the ultimate risk still isn't high, as long as the value of these assets doesn't go to zero. It should actually come back up over time; you know, the recovery, and we'll surpass the previous price levels eventually; well before the end of lots of Fannie and Freddies mortgages, and they'll be a net gain for everyone. Yah! But if everyone panics on Fannie and Freddie now, its equivalent to a run on the bank, except this bank is the bank that buys most of the mortgages in the country. Take out the biggest buyers in a market, who offload the risk of default from an originator; who's going to buy the mortgages? Yes there's some private investment, but to attract the levels you'd need to support any kind of a reasonable housing market, the rate on a FX30 would skyrocket. Again, pushing down the number of buyers in the housing market, and driving down prices, and you eventually get another run on a private investor...and then another...and then another.

I'm just saying what I think the consequences would be.

 
At 7/25/2008 7:10 PM, Blogger juandos said...

Hello again housingman...

Your comment: "What they own are the vast majority of normal, conforming 30-year fixed, et al. products that your regular person has as a mortgage"...

Doesn't that bother you that these two federal entities are in what should be a private business?

"The risk lies in the fact that the mark-to-market of the underlying asset--the house--has fallen like 20% across every market; something that well, was generally consider not that high of risk"...

This couldn't be also due to the fact that maybe, just maybe the housing was overpriced in the first place, could it?

"Take out the biggest buyers in a market, who offload the risk of default from an originator; who's going to buy the mortgages?"

Those who might think its worth the risk...

There's still a lot of real money in those loans and something like 95% or so are NOT defaulting on their loans...

"the rate on a FX30 would skyrocket. Again, pushing down the number of buyers in the housing market, and driving down prices, and you eventually get another run on a private investor...and then another...and then another"...

O.K. then what would the end result be in your estimation?

People thrown out of their houses?

The actual price tag of the houses up for sale goes down?

Would banks go out of business?

I was still under the impression that those with savings that were covered with FDIC would still be O.K., am I wrong?

Wouldn't banks now that the Indy outfit went under (will others?) be a bit more circumspect about their home loan proceedures?

Let me ask you this since you obviously know a lot more about housing and its related workings, what would be the real downsides of a house prices dropping?

Wouldn't that also mean the prices of materials and labor going into making new houses also drop?

Thanks for you info housingman...

 
At 7/25/2008 9:01 PM, Anonymous housingman said...

First off, take a look at this for perhaps a little better understanding of how the mortgage system works; its simple but pretty accurate.

What you can see is that the issuer basically assumes all the risk. In some cases, the issuer is the FHA/VA (which is government funded), or Fannie and Freddie, the former of which was created by government charter in 1934 to provide liquidity to the secondary mortgage market, and retained a monopoly until '68, when it was privatized and Freddie was also charted as competition.

What I'm saying here is that banks don't like the risk of a mortgage, even just a normal one. The rate of return really isn't very good. Its better to try to originate and sell the mortgage, and possibly keep the servicing. Banks will do a few for private banking customers, and they will do their own business in the private secondary market with things like Jumbo loans that Fannie and Freddie are banned from buying. So to get the private investors interested, you need to hike up the rates.

Now back in the Great Depression, and yes, I know it sounds spooky to invoke that, but there was private secondary, and there was the banks themselves doing the loans, and when things went south, the banks said 'no' to any loans, and so did private investors, so no one could originate.

And so...yes to the fear of the free market, the government stepped in and provided liquidity buy saying 'look, we'll assume the risk of making mortgages.'

And actually, from strictly a economics perspective, there is one way this actually makes sense and makes things cheaper for everyone. By assuming a large pool of risk, then distributing it over a large pool to investors, the risk is diluted greatly; especially because these institutions have specific guidelines for what kinds of loans they can purchase. Its an economy of scale, plus a massive credit line. And the 2 chartered GSE's are basically the same, because they are so huge they can pull from a massive pool of differing loans to dilute risk, and with that implicit-now-made-explicit gov't backing, their credit was beyond (and traded above) AAA.

My point is, and I don't think any economist can dispute this, the free markets can be irrational at times. And this is one of those times in terms of housing; creditors are continually panicking because of the MTM writedowns.

What caused the write-downs? Lol, you won't believe it...the free market. Subprime was all about originating a product that you couldn't sell to Fannie or Freddie, but you found a private buyer for, who would buy these loans en-masse and package into bonds, thinking they had replicated what Fannie and Freddie do, adequately diluting the risk.

So what went wrong? Well a bunch of things, but certainly there was demand in the private secondary market for the bonds, which drove the packagers, which then gave incentive to the originators to come up with the wackiest loans possible, that were completely unrealistic. Then the packagers made the mistake of assuming that they had adequately assessed the risk of these new products, of which they had zero history. So they took a bunch of products with completely different specifications, and if you look at how the credit agencies rated the bonds, it was a joke. They looked classy. You can also blame the borrowers for getting into loans they didn't understand or couldn't take on, but that also means that the originator didn't adequately price the risk of default.

So, subprime collapses when rates rise, floods the market with product. This begins to drive down prices, forcing selling in the backing debt market (and crashing or marking down a bunch of companies), but it also makes the typical selling in the prime market now difficult, driving down housing prices. Combine the factors that had run up prices in some markets as much as 200% in the preceding years, and it was a bubble bound to pop.

So yeah, the subprime is a mess, and that's a completely different problem. But what we're talking about here is that the complete PLUNGE in housing prices has made it impossible to sell, and the risk now of falling asset prices has banks worried about the risk of originating loans, which is why the spread between the FX30 and the prime rate is as high as it is; its a good indicator of bank's view on the risk of originating a conventional loan, otherwise the basic FX30 on the market will move in lockstep with Prime.

So again, with an irrational private market, Fannie and Freddie have been strained of capital by the market and forced to play their hand, the gov't credit line. I suppose you can argue the market isn't irrational right now, but please do look at the foreclosure numbers on the underlying assets and then determine what you think the real risk is. If the institutions were abandoned, well, I can't exactly say. Maybe you can believe that the market will get over its fears on its own, but you'll still face the problems of these cyclical crashes without large institutions and diluted risk. And even then, apparently that's not enough until someone backs all $5.2 trillion of their assets.

And yeah, their bond holders benefit from the bailout, and that's BS. The point of action here is to stop the irrational behavior, not compensate anyone's loses.

Anyway, just my $0.02.

 
At 7/25/2008 11:00 PM, Blogger bobble said...

"MP: If you make the world safe for idiots (and reckless borrowers, investors and executives), you'll create a world full of idiots (reckless borrowers, investors and executives)."

yes, i couldn't agree more. let's repo the homes and incarcerate the executives

 
At 7/26/2008 1:45 AM, Blogger OBloodyHell said...

It's an inevitable result of civilization:

Too Much Tiger Food,
Not Enough Tigers.

 
At 7/26/2008 1:50 AM, Blogger OBloodyHell said...

> Debts are fixed. No?

Correct: No.

A substantial problem with the assets is that they don't list the huge addition to worldwide (as well as national wealth) inherent in IP -- the current systems do a markedly poor job of estimating, much less charging, other nations with IP piracy, both individual and commercial. Our so-called "debt" in many cases is actually far less than it is, both in real and theoretical terms. If China attempts to get nasty about accepting our money, we have the option to get nasty about the amount of Chinese piracy of US IP -- software, media, etc.

The fact of the matter is, the system is screwed sideways, and until enough people start paying attention to that, and work towards revising it, they are doing nothing but rearranging deck chairs on the Titanic.

 
At 7/26/2008 2:03 AM, Blogger OBloodyHell said...

> The risk lies in the fact that the mark-to-market of the underlying asset--the house--has fallen like 20% across every market;

Well, if you were a complete idiot, I suppose you could claim that. Since that's what we are talking about, in essence, I don't see where your argument is based.

Anytime the market shoots up by 50% in a short time, it is a bad idea to assume it's going to stay that way without a downturn first (yes, it's likely to rebound, but not before taking a dive).

Literally, it's flat out stupid. Perhaps by losing a good chunk of money, you'll learn something. If not, then at least that money will be in the hands of someone who will make better use of it than the idiot who did not grasp the above, and still can't.

> its equivalent to a run on the bank, except this bank is the bank that buys most of the mortgages in the country.

Which is why such a thing should not exist in the first place. A certain measure of bailout to keep things stable might be called for, but no more than absolutely necessary and THEN only with the expectation that these monstrous abortions of big bad government should be broken up ASAP to reduce their ability to make the same wrong decisions and f*** up the entire housing market.

And the idea that a government screwup is somehow a justification for rejecting "libertarianism" is just so preposterously absurd that one has every justification to express doubts regarding your intellectual and rational skills just for making the proposition in the very first place.

 
At 7/26/2008 8:57 AM, Anonymous housingman said...

OBloodyHell said: "Well, if you were a complete idiot, I suppose you could claim that."

Come on, that's not necessary. If you disagree, then explain where you think the risk is that has caused creditors to pull their money.

"Literally, it's flat out stupid [to buy in a bubble]. Perhaps by losing a good chunk of money, you'll learn something."

There's two sides to every transaction, and in this, there were multiple transactions in which everyone was a willing participant and made mistakes. Except Fannie and Freddie; they honestly didn't screw up, their assets just lost value because a ton of product got dumped on the market.

In a subprime-gone-bad, the buyer made the mistake of getting in a load they couldn't take, or didn't understand. The originator+the private buyer of the loan screwed up in assessing the risk of default and charging the appropriate premium. The packagers screwed up in their models of diluting risk, and the credit rating agencies screwed up in rating those repackaged assets as relatively high-quality.

Those private investors, those originators, well, they've taken a lot of losses already, and most of the subprime-only originators are bust. The borrowers? Well they are slowly getting fuct too, as the structure of ARM's set up a ladder of mortgages with rising rates as they were originated. Sympathy for the borrower or not, the problem remains that the investment community made it possible for these people to purchase property unrealistically, which inflated prices as demand increased, and now as the rates increased and defaults rose, supply has crushed the prices in the market. I mean, it ain't rocket science.

So yes, everyone is to blame here who was involved on the sub-prime side. But those doing normal business, business that had good risk models and pricing, and good processes for verifying a buyer's ability to pay, like Fannie and Freddie's conforming products, didn't screw up. They got caught in a market that we haven't seen the likes of since well, 1930.

 
At 7/26/2008 9:05 AM, Anonymous housingman said...

Let me give another example, the SISA or Stated-income, Stated-asset loan. This was originally a product for people who do not have a verifiable income; people like authors et al. who make money big chunks at a time at irregular intervals. They know they'll have to pay a higher rate because of their unusual situation, but there's still a loan for them. Basically they tell the originator how much money they have, and how much they make, and the originator never verifies this in any way. Now there's other ways to get this person a loan. I used to call this a 'mafia' loan; the loan where you don't want anyone asking questions. Basically you're saying 'yeah I can pay, and I'll take a higher rate for you not to check on my ability'.

And you know what? Banks did these. Not just little shops, but your regular big retail banks, and the premium on the rate for the loan was not nearly high enough for what should have been perceived as an exceptionally high risk.

And like I've said, no one would originate this if there wasn't private buyers ready to pony up for this garbage. Fannie and Freddie weren't buying things like this (because the government doesn't allow them to), but your major financial institutions were.

 
At 7/26/2008 10:12 AM, Blogger the buggy professor said...

I have repeatedly praised Mark Perry's data-filled posts . . . always illuminating and full of prods to reflection even for someone like me, a moderate independent and not a libertarian.

Today, in this thread, I'd like to praise the informative exchanges here left by the individual posters. Except for obloodyhell's, your clashing views were expressed with civility and were, like Mark's posts, informative and illuminating . . . especially for me, something of an ignoramus about the housing market.

.....

On my own web-site, which admittedly deals with controversial political issues (among other things), the degree of civility tanked within a few weeks of its start back in 2003, and I got so many death-threats that the local UCSB police put me in contact with the local FBI office.

Even then, I --- who never voted for George W Bush, but supported the multilateral (!) intervention to topple Saddam Hussein --- continued at the request of the FBI to keep the posts open.

I did.

Alas, almost as bad, within a few weeks more, practically every gambling casino in Asia, Latin America, and on the Mississippi river started leaving advertising posts . . . followed, soon afterwards, by dozens of porno sites. Word verification of the sort that Mark's site requires did not seem to help. The unasked-for ads keep piling up.

Finally, when atomic-blasts of posts landed within a few minutes that broke down the site's end-server to the Internet, I had, alas, to shut off the posts. Too bad. Despite the haters, the porno-pundits, and the gamblers, there were several posts from fellow academics and students that were thoughtful and --- even if at odds with my analysis --- good prods to further exchanges in which I participated.

.....

Maybe obloodyhell could reflect a moment on these comments.

....

Thanks again, Mark and all the posters in this thread.

My own economic preferences (I've a Ph.D. in both economics and political science)? If market failures exist or look like emerging, we should generally be careful in looking for government regulations to deal with them, but not all regulations are bad, not all will worsen things, and that is particularly the case when it comes to making financial institutions of all sorts completely transparent and accountable to investors and borrowers.

On this score, at least federal support for savings accounts in banks has prevented a panic run on several banks of the sort that occurred in the early days of the Great Depression. Similarly, thanks to government-backed mortgages --- the risks involved in which have been carefully explained by housingman --- home ownership in the United States has grown over the years and has reached nearly 69%.

.......

Michael Gordon, AKA, the buggy professor: http://www.thebuggyprofessor.org

 
At 7/26/2008 1:23 PM, Blogger juandos said...

Hey housingman, thanks for the reply...

It is illuminating to say the least...

I do have one question about this by you though: "So what went wrong? Well a bunch of things, but certainly there was demand in the private secondary market for the bonds, which drove the packagers, which then gave incentive to the originators to come up with the wackiest loans possible, that were completely unrealistic"...

Could those demands be the result of federal interference regarding what they call, "fair housing laws"?

 
At 7/26/2008 4:23 PM, Blogger OBloodyHell said...

> Now back in the Great Depression, and yes, I know it sounds spooky to invoke that, but there was private secondary, and there was the banks themselves doing the loans, and when things went south, the banks said 'no' to any loans, and so did private investors, so no one could originate.

And so...yes to the fear of the free market, the government stepped in and provided liquidity buy saying 'look, we'll assume the risk of making mortgages.'


1) You invoke "The Great Depression" -- which pretty much ALL economists, even the Keynesians, now grant was almost entirely CREATED by the actions of the Government and the FRS -- when the banking crash started, they tightened the purse strings on the money supply, which REDUCED the amount of cash available to those involved in the Fractional Reserve Banking System, which led (gee, what a surprise!) to banks not being able to even GET cash if their customers asked for it -- which led to a panic at a specific bank, which rumor turned into a panic at other banks, and led to the collapse of literally thousands of banks in short order.

Further, with the banks gone AND no cash to be found, it seems rather INCREDIBLY "DUH" that risk capital, i.e., "investment capital", which does not only include venture capital for economic development (at the riskier end of the spectrum) but also home loans (at the less risky end, since it comes with a measure of built-in collateral, the home & land involved) -- it seems rather DUH that the available sources would shrivel up and disappear temporarily, at least until the money supply expanded again.

So, TAH-DUH-DA!!!!

The Government steps in to save the day, "fixing" the very same problem it created in the first place, and creates FM. Whoop-ti-doo.

The fact of the matter is that this activity existed for CENTURIES beefore we decided that the Federal government needed to horn in on it and chase out all the independents which had done it to that point.

By creating a single monolith, it has set up a situation where both the ones making the loans (the banks), the ones taking the loans (the buyers), ALL have their risks reduced, which leads inevitably (why would anyone be surprised?) towards poorer and more risky investments?

...and now the idea is to bail out said same idiots on the basis that the government will "fix" the fix to the problem it created in the first place.

At the cost of a mere trillion or so...

:-/


You starting to see the point?

I will grant you, we may well need to do some things to make sure the situation doesn't wildly oscillate out of control, butit should be as little as possible, and the whole system needs to be broken up so that one monolith isn't making the same idiotic mistake again.

A network of smaller organizations will have more cushion against errors, so that the failure or complete fuckup of one won't bring the whole damned system down.

And we damned sure should get the fed out of guaranteeing the whole thing, because the Fed can't do anything right, for the most part. Look at the Post Office, which is about the only organization in the entire planet which can claim it needs to "raise prices" because it's doing too much business. Look at the Centralized Educational System, which claims it "needs more money" to educate students despite the fact that across the board it gets, on average, twice as much per student as Catholic Schools do, but produces 30-50% literacy rates, unlike the Catholic Schools.

When pondering "Public XXX" think of the "Public Toilet". There is a reason one doesn't go looking for public toilets when one needs to go.

 
At 7/26/2008 4:43 PM, Blogger OBloodyHell said...

> Except Fannie and Freddie; they honestly didn't screw up, their assets just lost value because a ton of product got dumped on the market.

Oh, don't be silly.

a) Their very existence is a screwup, see above missive.

b) Even granting "a", and ignoring it -- they give money away to be loaned (directly or indirectly does not matter -- by assuming the risks, it is essentially "their" [i.e., the citizenry's] money at risk, not that of the lender), so it is clearly UP TO THEM to make sure that the loans being made are adequately covered by the properties in question. And YES, that means that THEY need to be able to grasp what a "housing bubble" means to the valuation of houses, and to make sure that the lenders care about the risks involved -- because it's in their own interest to make sure the loans are adequately covered.

Which leads to...

c) In regards to that final sentence above, you begin to grasp the problem -- as a government organization, they don't care, do they? "Hey, it ain't *MY* money, izzit?". The same thing is true of the lenders: "Hey, it ain't *MY* money, izzit?". And, to a lesser extent, of the buyers: "Well, I got to live in that really expensive home at ridiculously low prices for a while, at least!"

They ALL have no horse in that race. They don't lose their jobs, they don't lose their "company" -- they get to take the money away from ME (and everyone else here) at gunpoint to take care of people who made the bad choices at the start of all this and think that somehow WE are supposed to foot the bill.


=========================

And this defines the heart of the problem:

When "the government" starts DOING things for us, they start making OBLIGATIONS on our behalf which, more often than not, are not obligations a prudent person would accept.

So it eliminates the ability of a person to BE prudent, because suddenly they've given an idiot their power of attorney.

There are SO MANY things which the Fed has a hand in these days which are blatantly NOT things which the Fed is even vaguely good at much less SHOULD be doing under their Constitutional Mandate.

As a result of the current 50-50 taxation scheme, it only takes 51% of the population (and actually less) to demand things of the other 49%.

Any idiot can see how that leads to one of the key factors in the fall of Rome -- "Bread and Circuses". Once the majority grasps that they can take things from the more productive among them, they start to do so.

The grasshoppers take over and enslave the ants.

 
At 7/26/2008 4:57 PM, Blogger OBloodyHell said...

> And like I've said, no one would originate this if there wasn't private buyers ready to pony up for this garbage. Fannie and Freddie weren't buying things like this (because the government doesn't allow them to), but your major financial institutions were.

If the MFs (sorry, "FM"s) weren't involved, how do they get affected by it, then? This isn't the FR banking system where suddenly they get on the hook for payouts caused by scared people looking to pull their money out of completely solvent banks. No one is terrorized to find that their next door neighbor's mortgage company has gone belly up, so they go out to their FM lender and... what, try to pay off their loan?

If the FMs are affected, they are linked to these foundering companies in some way that matters, and THERE lies their screwup.


-------------

Codicil: I don't claim to be an expert in these matters (sorry if I've given that impression so far), but I do read enough that I don't think we've gotten outside my own feel for what happens and has happened. Unless there are some pretty hinky underlying details, I don't think I'm wrong here. The FMs are not absolved of their hand in this. If they are obligated to cover these bad loans, then, by all means, explain to me WHY when you're claiming THEY only made "good" loans. That is ridiculous.

From where I stand, this is just another round of the 1980s S&L system screwup, which -- surprise, surprise, surprise, was yet ANOTHER "New Deal" era "financial" development which stopped having contact with the "Real World" and managed to screw up royally.

Those idiots in the FDR admin thought they could ignore accounting. So we are still paying for their complete cluster f***s. And, with Social Security and Medicare/aid on the horizon, we ain't done yet.

>:-(

"The only thing to fear is FDR himself"

.

 
At 7/28/2008 10:12 AM, Anonymous housingman said...

Well, its seems like no matter what, there's this thesis that gov't intervention is bad, and the free market is the most efficient mechanism for everything.

I'd argue that that's not always true, especially in times of irrationality and fear by investors. Many people in this thread have admitted themselves to not understanding exactly how the secondary market works, yet they may own, or short Fannie or Freddie stocks. That's ok, no one can be expected to know everything about everything they invest in, however in times of fear, people tend to panic, and right now, anything exposed to housing is considered toxic.

So the real over-arching debate here, and I'd say largely on this site in general, is to what extent, if any, should the State be involved in the Economy?

At one point in my life, I was an ardent Objectivist, but I've come to different conclusions since. Most notably, I appreciate the work of Joseph Stiglitz and Paul Samuelson, both Noble-prize winning economists, both of whom certainly have received their share of criticism as well.

So while a free-market will self-correct, there's significant economic pain that must be endured first, and that pain (IMHO) is not necessary. Fear is a natural part of the free-market cycle, and unfortunately it has painful consequences. We have developed some mechanisms to mitigate this, like FDIC, which I think most people feel is a good thing for the regular person; it removes the fear of losses in a bank failure. Should we scrap that?

These are all real, substantial, and quite debatable issues, on which there are many views. I'm by no means a socialist, but I do think that amplitude of the natural oscillations of the free market can be dampened by some gov't intervention, and ultimately that leads to better economic cycles that benefit everyone in the long run.

But at this point we have digressed from the original topic. Hopefully at least there is some more insight into how Fannie and Freddie work, along with the mortgage market, and what I feel are the causes of their woes (oversupply of product on the market) versus the woes of subprime (bad business).

 
At 7/28/2008 11:44 AM, Anonymous housingman said...

"The FMs are not absolved of their hand in this. If they are obligated to cover these bad loans, then, by all means, explain to me WHY when you're claiming THEY only made "good" loans. That is ridiculous."

When you loan someone money, its obviously a risk, and you charge what you think is the appropriate premium for that. If you want to blame Fannie and Freddie for continuing their normal business without increased risk mark-up while the sub-prime mess was on its way up, then ok. Personally, I don't. You have to look at the so-called conventional wisdom in the market, that all these supposedly very smart and large financial institutions were buying sub-prime debt suggested the model was sound; and it obviously wasn't.

Fannie and Freddie failed to anticipate the massive failure of sub-prime, while they themselves held almost entirely prime mortgages. Those mortgages even now are largely being paid on-time, its just that the underlying assets have been crushed in value.

So call it a mistake if you will, but I don't think they bought 'bad' loans, after all, they own loans that still have much lower default rates than sub-prime debt, although all default rates have risen in this bad environment. Relatively speaking, this is about the best mortgage debt you could own.

Basically every mortgage originated in the last 5 years is probably close to 'bad' given the drop in housing prices, but there's no way you could have known that at the time. If housing prices come back up and the borrowers don't default, these mortgages will go back to 'good' with ease. We just need to get there first; I don't think anyone disputes that eventually, housing prices will return, in some markets faster than others.

 
At 7/29/2008 2:28 AM, Blogger OBloodyHell said...

Don't know if anyone is still reading this thread, but:

Fannie and Freddie are the poster children for a lack of transparency and accountability. Fannie Mae employees deliberately manipulated financial reports to trigger bonuses for senior executives. Freddie Mac manipulated its earnings by $5-billion. They've misled us about their accounting, and now they are endangering financial markets. More than two years ago, I said: "If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose." Fannie and Freddie's lobbyists succeeded; Congress failed to act. They've stayed in business, grown, and profited mightily by showering money on lobbyists and favors on the Washington establishment. Now the bill has come due.
John McCain in an editorial piece

It seems relevant.

 
At 7/29/2008 3:05 AM, Blogger OBloodyHell said...

> there's this thesis that gov't intervention is bad, and the free market is the most efficient mechanism for everything.

I can't speak for others, but that's not precisely true.

I believe that the Fed, in particular, does an egregiously bad job at anything because it has very poor accountability. It has rotten accountability at the bureaucratic level (few bureaucrats lose their jobs because something important didn't get done, excepting in extreme cases like Shuttles exploding and highways collapsing -- and note that the high-level idiots at NASA didn't lose their jobs, just the mid-level engineers), and as far as politicians go, there is a reason why people were pushing in 1992-1994 for term-limits, an idea which the GOP conveniently forgot when they got into office (one of several reasons why, I think, they got the boot in 2006, along with SS reform and their general pandering to the Left whenever they said "boo"). Note that the average senator and rep serve many, many terms, unless caught with their hands in the cookie jar or some similarly extreme scandal.

Further, unlike business, they don't "go out of business" if they KEEP screwing up. They just get bailed out and get more money, and maybe someone gets moved sideways into a different position, mainly only if the screwup(s) are too visible or someone, somewhere, notices and makes a stink about it. Read Michael Crichton's piece about Complexity and Environmental Management. TELL me who at the Parks Services ever lost their jobs over those kinds of massive, repeating screwups. (These are the same sort of imbeciles who think they can "manage the climate", mind you).

This does not mean that there is NO possible regulation or oversight which is good, only that most people look at things the wrong way -- the government is a fucking LOUSY mule to pull the cart. It does make a damned fine carrot-and-stick, when we discuss, openly and carefully, where we want the cart to go. But we should avoid, as much as possible, making the government the cart.

Only a government entity like the Post Office could make a ridiculous claim like "volume is up, so we have to raise prices". There is not a single service business on the planet which would make that claim. It's assinine.

> We have developed some mechanisms to mitigate this, like FDIC, which I think most people feel is a good thing for the regular person; it removes the fear of losses in a bank failure. Should we scrap that?

You see, this is exactly the kind of thing of which I speak -- why can't the Fed set guidelines for insuring these organizations, then let private industry do so? The "I" is insurance. What makes you think that private companies can't provide that service.

As far as "why not the government", well, I think the S&L problem of the 80s showed exactly what I'm talking about, in exactly the area you suggest: it was the failure of the equivalent FSLIC to provide proper oversight of the Savings and Loans that cost taxpayers an estimated 150 BILLION dollars -- that's about $550 per person in the USA (assuming 275 million people). (Note: 1980s dollars, that's, what, ca. 300 billion today? More if you allow for inflation of incomes to make it more "representative" of the impact of such on the average taxpayers' pocketbook)

If that had been done by multiple independent insurance organizations, it probably would not have been as widespread, and might have been caught sooner, since people would have had a particularly significant interest in making sure that things stayed on track.

==============

NOTE: any system which encourages/allows bailouts needs to have substantial ability to punish those individuals who have failed as guardians... the eternal problem so old it's in Latin: Quis Custodiet Ipsos Custodes? So you have to consider that when setting the principles upon which these guardian insurance companies operate, including, for example, rules for criminal, not just civil, failure to perform -- it has to tie to corporate officers as well as to the poor schnook accountants... and to the possibility, not just the provability, of negligence. You have to make it more than just their jobs to make sure that the people beneath them are doing their jobs correctly.

Back to that accountability issue, mind you.

 
At 7/29/2008 3:34 AM, Blogger OBloodyHell said...

> I do think that amplitude of the natural oscillations of the free market can be dampened by some gov't intervention, and ultimately that leads to better economic cycles that benefit everyone in the long run.

That can be argued, but the thing to remember is that, when they screw up, they screw up BAD -- really, really bad:

There is no question that both the length and the depth of the Great Depression were tied to improper actions by the Federal Reserve System, which was set up for EXACTLY the purpose you describe -- to smooth out the boom and bust economic cycles of the past, especially as a response to the moderately bad Panic of 1907.

As bad as those things were, though, they did not hold a tiny glimmering candle to the sunlight that was the Great Depression. The Depression just about ruined this country -- if it were not for the nature of the American people, it probably would have (look at what a similar thing did to Germany's Weimar Republic), and I truly do fear what such a thing would do to America today, with people having so little real faith or understanding of the system devised by the Founders*.

======
* Mildly OT -- I cite to you that the Founders did something pretty damned impressive -- the current US government is now over 220 years old, with a continuous and largely unaltered form for the entirety of that time frame. Not only does that make it one of the oldest governments on earth, it is THE oldest such government of any major nation. Even the UK has transited from a full monarchy to a parliamentary, figurehead monarchy in that timeframe. Most other nations have been through several intervening forms in the same time frame. I'm sure there are some other governments (oh, Lichtenstein, say) which may have an older contiguous presence, but none of them are of any significance on the world stage. I would suggest that there are few other governments in human history which have exhibited that kind of consistency and stability, either.

Consider that, with the 2000 election, we went through a defacto Constitutional crisis, with little more than a bunch of ill-feelings. No one even thought to pick up a gun and declare themselves the ruler. How many nations in human history do you think THAT would have been true in?

Q.E.D. -- the Founders did something damned impressively right when they designed the structure of this nation's government. And we should be very wary of efforts to tinker with it or when someone suggests it to be a "living document".

 
At 7/29/2008 3:48 AM, Blogger OBloodyHell said...

> but there's no way you could have known that at the time.

You ignore the point I made earlier. Why?

It is clear, when a market rises radically, that it is likely to fall just as quickly -- probably to a point above where it was before the rise, but well below the peak. This is just something markets do. Most markets rise gradually with time, partly as a result of increased wealth and competition for available resources, but also for other factors, too -- but when you see a tremendous rise in a short time, it's probably a sign of a spike or bubble -- people see the price going up, and either want to get on the gravy train (ala the stock market) or fear getting shut out (ala oil prices).

ANYONE who assumes that the market is going to stay up beyond, oh, 10% of the place where the curve's first order determinant changed substantially is just BEGGING to lose their shirt. They are clearly house trained, but there's little else to mark them as better than a chimpanzee. This is even more true of mature individuals (as opposed to "young punks") who have had an opportunity to see that happen again and again in various markets over time. Claiming that "no one could foresee it" is just flat out BULLSHIT. I'm not saying you PLAN entirely around it, but NOT assuming it can happen and incorporating that into your plans is just imbecilic. ANYONE doing price modelling should have brains enough to plan for a substantial downturn if the current rise turns out to be a bubble. People who failed to do that should LOSE THEIR JOBs. Anyone who bought a house presuming "it can only go up" deserves to lose whatever they have put into it. Even if you were flipping houses, you should have seen the downturn, smelled the future, and sold it at a distinct loss just to make sure you got most of your paper gains back out of it, and stopped there. I have no substantial empathy for a lot of these people. You live, you learn. Sometimes the lessons hurt. But those are often the ones you learn most effectively from. As Mark's title says:
"Want A World Full of Reckless Idiots? A Culture of Bailouts Will Work Pretty Well"

Think of it as "Tough Love".
:oP

.

 
At 7/29/2008 10:05 AM, Anonymous housingman said...

"Claiming that "no one could foresee it" is just flat out BULLSHIT. I'm not saying you PLAN entirely around it, but NOT assuming it can happen and incorporating that into your plans is just imbecilic."

Well, actually Fannie and Freddie cut back the number of loans they were doing starting in 2003. You can see Econbrowser's argument that Fannie and Freddie helped contribute to the current crisis. In any case, there is a lot of good information there, and you can see on the graphs that as housing prices inflated more and more, the GSE's were actually pulling back while private investors were pushing more and more $ in.

As for the accounting scandals at the GSE, yeah, pathetic. I know it probably sounds like I'm overly sympathetic to the GSE's, and that's not the case, but I will reiterate that from a practical standpoint, letting them go bankrupt would be a nasty process with equally nasty results on the housing market.

I am with you that the GSE's in their current form, this semi-privatized crap is no good. As to what form an idealized secondary market would take, that's a whole 'nother story...

 

Post a Comment

<< Home